Three years into the euro zone’s debt crisis, Germany’s finance minister hinted tantalisingly last week at a potential breakthrough.
Behind closed doors at a meeting in Paris of a small group of senior policymakers, Wolfgang Schaeuble indicated that Berlin could eventually agree to write off some of the money it has lent Greece, in order to make its debt sustainable.
Three people present or briefed on the talks said Schaeuble had suggested there could be some kind of «conditional debt relief» for Athens if it sticks to tough economic reforms.
But Schaeuble backtracked within 24 hours.
The idea, aired publicly this month by German central bank chief Jens Weidmann, could be a game-changer in the currency area’s crisis since it offers for the first time the prospect of sharing out losses to make the debt-crippled state viable in the long run.
But it is politically explosive in Germany, where many lawmakers, jurists and commentators fiercely oppose any idea of a «transfer union» in which wealthier northern EU states would subsidize or underwrite weaker southern partners.
Schaeuble told his peers from France, Spain and Italy and International Monetary Fund Managing Director Christine Lagarde that Berlin would be willing to consider a Greek debt write-down, not now but at a later stage, the sources said.
That pointed to a possible review of Greece’s debt outlook sometime after next year’s German general election, and before a second Greek bailout program expires in 2016.
The next day, Schaeuble ruled out any debt forgiveness at a wider meeting of euro zone finance ministers, leaving some of his interlocutors baffled. In public he said an official debt write-off would be illegal, and Germany would no longer be able to lend money to Greece.
The IMF, some senior European Central Bank policymakers and many economists argue that a «haircut» for Greece’s official lenders is inevitable because its debt ratio continues to mount despite a big write-down this year by private creditors.
An unpublished analysis prepared for the finance ministers showed Greek debt would peak at 190 percent of gross domestic product next year and fall to 144 percent in 2020, far above the 120 percent target set by the IMF and European lenders.
Euro zone ministers are considering lending Greece more money to buy back its own debt at a discount, reducing interest rates on official loans and extending their maturities, granting an interest repayment holiday, and passing profits on ECB purchases of Greek bonds back to Athens.
The moribund market in Greek government bonds has twitched back into life at the prospect, with prices rising to about 35 cents on the euro in anticipation of a possible buy-back.
But EU officials say all these measures taken together would not be enough to meet the debt sustainability target.
Lagarde has said she wants «a real fix, not a quick fix» to Greece’s debt problem and has held back the release of the next urgently needed 31 billion euro loan tranche for Athens to force the Europeans to address a lasting solution.
She rejected letting the target date slide by two years to 2022. Diplomats involved in the negotiations said Lagarde was looking for some sort of signal from Germany.
Schaueble’s closed-door comment may have been that signal. But it is not clear whether he had Chancellor Angela Merkel’s agreement to indicate a willingness to consider debt relief in the longer term, or whether he exceeded his authority and was pulled back into line.
“It turns out that Schaeuble may have exceeded his mandate from the Chancellery, if he had one,» an EU official briefed on the meeting said. «Anyway the idea of OSI (Official Sector Involvement) is now in the room.”
Apart from the political sensitivity of losing taxpayers’ money in Greece, Merkel sees three objections to a debt writedown – legality, precedent and investor confidence.
A legal opinion ordered by the German government suggests a «haircut» would breach both the «no-bailout» clause in European Union treaty and the German budget law, which bars lending to a country that may be unable to pay back the debt.
Any writedown would likely be challenged in the German Constitutional Court, which has already clipped Berlin’s wings in the crisis, and perhaps in the European Court of Justice.
Forgiving Greek debt could draw copycat requests from states such as Portugal and Ireland which are implementing similar bailout programs with less kicking and screaming.
Merkel is also concerned that investors such as the Chinese, who felt betrayed when euro zone leaders forced a «haircut» on private bondholders of Greece, would be even more alarmed if they saw a second write-down of European sovereign debt.
But the Bundesbank’s Weidmann said that a «haircut» on government loans to Greece could make sense as a reward for completing economic reforms and to help Athens regain capital market access.
The risk is that it would be so hard for Germany and other northern European creditor states to get a debt write-down through their parliaments that the scale of relief might be too small to give Greece a real boost.
One source in the thick of euro zone crisis management said it would make sense to «bite the bullet» and cut Greece’s debt by a substantial amount. But political constraints made it more likely that any relief would be «bite-sized» to bring the debt level down to around 100-110 percent of GDP by the target date.